What can I deduct as an independent contractor?
This month, we will look at some of the different categories of tax deductions available to independent contractors. Even though each entity—sole proprietor, C-corporation, S-corporation, and Limited Liability Company (LLC)—is required to file a specific tax form, and there are some differences (especially at the state level), the rules for deductions are predominantly similar, particularly for a single-member or "closely held" entity.
First, according to Internal Revenue Service (IRS) Publication 535, Business Expenses, "in order to be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary." Because of the broad scope of this definition, in audit, IRS generally only denies the most flagrant expenses—and more often attempts to differentiate and deny non-deductible personal expenses. However, even the business use percentage of an otherwise personal expense is also deductible (such as the portion of a vacation spent conducting business.)
Also, IRS always looks at the individual "facts and circumstances" of a claimed business deduction to determine if there is a "preponderance of evidence" to support the use of the expense to reduce income. As a result, a given expense may be deductible for one business, but not another. IRS also requires documentary evidence of any expense over $75, such as receipts, bills, or cancelled checks. A diary or log is sufficient evidence for mileage deductions.
Most independent contractor business deductions reduce net self-employment income—which reduces self-employment tax (15.2%), as well as federal tax (up to 35%) and state taxes. The few allowable personal deductions (1040 Schedule A) and employee unreimbursed employee expenses (1040 form 2106) only reduce federal and state taxes.
If you maintain a permanent "tax home" that you return to on a regular basis to live and work, then you may deduct travel expenses between temporary assignments (less than 12 months). Any additional costs for your family would not be deductible. If you do not maintain a permanent home, then you are considered an "itinerant worker"— wherever you work is considered your tax home, and the travel expenses between assignments are not deductible. If your assignment is, or becomes permanent, then you may deduct some costs as personal moving expenses (on 1040 form 3903), but not as business expenses.
Should your agency not provide reimbursement for travel (typically airline fares), hotel, rental car, or gas, you may deduct these out-of-pocket travel expenses. Additional items that can be deducted include fees for U-Hauls, packing supplies, storage, tolls, parking, and vehicle expenses such as mileage.
These types of costs are deductible when traveling between temporary assignments (less than 12 months) and while on temporary assignment. They are not deductible for personal use, including commuting to and from a permanent job.
There are two ways to deduct vehicle expenses—using either the business-use percentage of actual expenses or using the current federal mileage rate. Actual expenses include gas, maintenance, repairs, insurance, license, lease payments, and/or depreciation. The mileage rate for 2005 is 40.5 cents per mile; up from 37.5 cents for 2004, and includes all vehicle expenses except tolls and parking.
TEMPORARY LIVING EXPENSES
Generally, the largest deduction for locum tenens physicians with a permanent home is temporary living expenses while working away from their residences. If you maintain a permanent home, and return there on a regular basis to live and work, then you may deduct all duplicated out-of-pocket expenses while on temporary assignment—including housing, utilities, and half of your meals. As an alternative, you may use a daily meal per diem rate from IRS publication 1542, without receipts. However, keep in mind that you may not deduct the lodging per diem found in this publication, which is for employers to use for reimbursements.